Where do investors tend to put their money in a bear market?
A bear market can happen in stocks, bonds, or commodities, and of course, it is never announced in advance. In any case, if you think one is coming, you have to define how large of a valuation drop constitutes a bear market (many opinions on this), and how long the bear will stay around.
Deciding to defend against a bear market can be complicated if your invested assets are in a taxable account. Uncle Sam will want a piece of your realized gains if you sell investments and go to cash, the piece he takes depends on whether the gains are long-term or short-term, and what your marginal tax rate will be.
The most direct answer would be, investors move some money to cash, not so much to defend, but to create the ability to be opportunistic, and this move is ideally made prior to a market being defined as a "bear market" by the press. I say defend, because most "investors" remain mostly invested for the long-term, because constantly jumping in and out of the market is often ineffective and expensive from the standpoint of opportunity cost, transaction cost, and tax cost.
Long-term investors would seek to offset some of the general market risk by adjusting allocation to less at-risk sectors of the specific market they are invested in. e.g. favoring government bonds over corporate bonds, short term maturities over long term maturities, value stocks over growth stocks, underweighting and/or overweighting specific sectors, etc., etc.
If you are a long-term investor, and can lose less when the markets retreat, and stay with the market when markets advance, typically you win the game.
Hope this helps,
Many investors leave their investments in the market and suffer through the bear. But this probably isn’t what you are asking.
There are several strategies for surviving and prospering in a bear market. It all depends on your risk tolerance.
- Go to cash – Sell everything and wait out the bear market with no principal risk
- Eliminate the highest risk securities – Sell the investments that may be at the most risk. The more you sell, the less exposed to the bear you are.
- Shift to low volatility stocks – Shift from high flyers to dull and boring stocks like utilities. You may still experience the bear, just not quite as badly.
- Shift to short term bonds – This is a way to ride out the bear and still make a little more money than a money market.
- Deploy some inverse ETFs – These are not for the faint of heart. They are designed to go in the opposite direction of the index they mirror. If you believe the market could drop substantially, this is a way to make money on the decline. If you are wrong, it’s a way to lose lots of money.
These are some of the main options to choose from that don’t involve too much risk. It is far from an exhaustive list. There’s the futures market, shorting, options and several other strategies that involve more complex and risky strategies.
Bear markets can give signals for a long time before it starts. If you do deploy any bear market strategy, be prepared to be wrong for a while.
A bear market is traditionally defined as a period of negative returns in the broader market to the magnitude of between 15-20%, or more. During this type of market, most stocks see their share prices fall, often substantially. There are several strategies investors employ when they believe that this market is about to occur or is occurring, and they typically depend on the investor's risk tolerance, investment time horizon and objectives.
One of the most conservative strategies, and the most extreme, is to sell all investments before the downturn begins or before it hits its lowest point, and either hold cash or invest the proceeds into much more stable financial instruments, such as short-term government bonds. By doing this, an investor can attempt to reduce his or her exposure to the stock market and minimize the effects of a bear market.
But this strategy requires knowing when to sell, and bear markets can be very difficult to predict. As Ryan Miyamoto, a CFP® in Pasadena, CA, explains, “Selling at a loss is your biggest threat. A bear market will test your emotions and patience… The best strategy to control your emotions is to have a game plan. Start by creating a safety net that is not invested in the market. Seeing your accounts go down will be a lot easier if you know you have adequate cash on hand.”
Paul R. Ruedi, a CFP® financial advisor in Champaign, IL, suggest investors regularly do “lifeboat drills” before a bear market starts. He says investors should “...imagine a bear market has occurred and the stock portion of their portfolio is down 20% or 30%. How will they feel? How are they going to react? Are they going to panic, or remind themselves that “this too shall pass,” and stay the course with their investments? We remind our clients to do these all the time, and when a bear market occurs, they are spared the panic and emotions that consume most investors during bear markets.”
For investors looking to maintain some positions in the stock market, a defensive strategy is usually taken. This type of strategy involves investing in larger companies with strong balance sheets and a long operational history, which are considered to be defensive stocks. The reason for this is that these larger, more stable companies tend to be less affected by an overall downturn in the economy or stock market, making their share prices less susceptible to a larger fall. With strong financial positions, including large cash holdings to meet ongoing operational expenses, these companies are more likely to survive downturns. These also include companies that service the needs of businesses and consumers, such as food businesses (people still eat when the economy is in a downturn) and companies that sell basic consumer goods (people still need to buy toothpaste and toilet paper). In this same vein, it is the riskier companies, such as small growth companies, that are typically avoided because they are less likely to have the financial security that is required to survive downturns.
As Benjamin Westerman, CPA/PFS, CFP® in St. Louis, MO explains, many investors look to bond holdings and cash during a market downturn. “Bonds are your “sleep at night” money that is protected during a bear market, while you wait for your investment portfolio to recover. In addition, if you have any money on the sidelines or are still in the accumulation/savings phase of your life, this is a great opportunity to invest in equities while stocks are on sale.”
As investors will find, there is a wide range of other tactics that can be tailored to a bear market. The most important thing is to understand that a bear market is very difficult to predict, and to remember that most strategies can only limit the amount of downside exposure, not eliminate it entirely.
From a logical perspective the perils of attempting to exit the market before it goes down are well documented. However, when asked: What do investors collectively tend to do during a bear market? We see that they often react by pulling money out of the market and flee to shorter term fixed instruments such as money market funds or CD’s. According to the Investment Company Fact Book, during the 2008 downturn investors withdrew $211 billion from mutual funds, while money market funds saw a net increase of $637 billion.
Reacting during a bear market can often be detrimental to long-term portfolio growth, especially during periods like the relatively short 17-month bear market from October of 2007 to March of 2009.
Many retail investors will actually stay put because they have been told "you can't time the market." Many will finally say Uncle when they reach their pain threshold. Every bear market is slightly different. In 2008, the place to be was treasury bonds, gold, cash, and shorts using inverse exchange traded funds (ETFs) betting the market will go down.
But if you rely on some type of technical indicators, cash is the most conservative, simply covering up until the dust settles. Investment grade bonds and treasuries historically have been a safe haven. But with interest rates likely on the rise, it won't be so certain this time and the bubble may actually be in bonds. They are currently already off between -5% to -7% depending upon the bond sector. But using short selling ETFs are a simple, elegant way to either make money or simply hedge your long positions you don't want to sell. This can also be owned inside an IRA or retirement account whereas shorting individual stocks cannot. You also don't have to worry about margin interest or margin calls.
I personally will use a combination of cash, short term bonds, and short selling ETFs. I will also consider gold depending upon how it is acting at the time.
Hope this helps. Happy Holidays, Dan Stewart CFA®